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Hi Traders,
Today’s focus is on understanding the direction of the trend and strength of the trend. This is part 3 on our series of defining the trend. You can see part 1 and part 2 by clicking on the respective links.
Direction of the trend
Defining the trend might not be as simple as it sounds when taking into account multiple time frames, various moving averages, different channels and multiple trend lines. Price moves on many different levels and the ‘stories’ of the various time frames can quickly become confusing.
Conflicting messages are certainly not uncommon. Consider the following question that many traders face each trading day: “am I viewing a pullback within a new trend or is the ‘old’ trend still valid and has price just changed gears?”
Trending market
I personally combine classical highs and lows, trend channels, fractals and above all moving averages to answer that question for my own trading. I use 4 hour chart for swing trades and a combination of 1 and 4 hour charts for intra-day trades. In the section below I will discuss 4 various market structure 1) trending, 2) retracing, 3) reversing, and 4) consolidating.
When price is aligned with the MA’s and the MA’s are aligned as well, then there is a very clear conclusion: the market is trending. Let’s review for bulls and bears:
Bullish trend:
MA’s: price is above the short-term MA (moving average – I use 21 ema), the short-term MA is above the long-term MA (I use 144 ema).
H/L: traders should be able to clearly see a sequence of higher highs and higher lows, especially higher lows.
Fractals: usually the fractals that are at/just below the 21 ema are very important and should not break. Fractals above the 21 ema are less relevant and not so important as a support level.
Trend channels: in some cases we are able to draw a channel on the chart connecting multiple tops and bottoms. With a channel there are many rules to be aware of, which will be discussed in a later post. Key is that the uptrend channel connects at least 3 hits on the bottom.
Bearish trend:
MA’s: price is below the short-term MA (moving average – I use 21 ema), the short-term MA is below the long-term MA (I use 144 ema).
H/L: traders should be able to clearly see a sequence of lower lows and lower highs, especially lower highs.
Fractals: usually the fractals that are at/just above the 21 ema are very important and should not break. Fractals below the 21 ema are less relevant and not so important as a resistance level.
Trend channels: in some cases we are able to draw a channel on the chart connecting multiple tops and bottoms. With a channel there are many rules to be aware of, which will be discussed in a later post. Key is that the downtrend channel connects at least 3 hits on the top.
Most of the time the 21 ema and the 144 ema will show an angle that is equal to the trend direction. So a bullish (bearish) trend should see bullish (bearish) ema’s as well.
Retracements
When price is retracing, it essentially means that the ideal trending alignment is missing. Let’s review for bulls and bears:
Bullish retracement: price is below (!) the short-term MA, the short-term MA remains above the long-term MA (I use 144 ema). Price will often break below the bullish trend channel and fail to post a higher high. It could potentially break support fractals as well.
Bearish retracement: price is above (!) the short-term MA, the short-term MA remains below the long-term MA (I use 144 ema). Price will often break above the bearish trend channel and fail to post a lower low. It could potentially break resistance fractals as well.
Consolidation
As mentioned in part 2, price is non-trending and consolidating as soon as the shot-term and long-term moving averages are touching each other. Price will go sideways and create flat channel. Fractals will be irregular and hold no pattern. There will be no sequence of higher highs or lower lows.
Reversals
The difference between a reversal and a retracement is the fact that price keeps pushing into the other direction, and eventually drags the short-term MA over the long-term MA.
In an uptrend the reversal occurs when price breaks below the long-term MA and eventually the short-term MA will cross the long-term MA to the downside.
In a downtrend the reversal occurs when price breaks above the long-term MA and eventually the short-term MA will be pulled above the long-term MA to the upside.
Of course when reversals take place, price will also break a trend channel (if visible on the chart). It will also clearly end the sequence of higher highs/low or lower lows/highs.
This concludes part 3 of our series on trend. But our quest to understand will not stop, next week we continue with part 4!
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